Tuesday, May 31, 2005

The Baltimore Sun makes a good point. Even if Bush loses the battle over Social Security reform, he may be able to salvage some political gain:

Bush
could draw voters through Social Security debate - GOP hopes to attract
young, minorities even if plan flops, By Julie Hirschfeld Davis, Baltimore Sun:
President Bush's drive to overhaul Social Security is foundering on
Capitol Hill and sinking in public opinion polls. But … Bush is
positioning himself to win - even if he loses. Bush is increasingly
targeting his Social Security push to minorities and younger people -
groups that disproportionately vote Democratic - in efforts to reap
electoral benefits for Republicans even if he ultimately fails to enact
his proposal. … Demographic data give Bush reason to hope that his
Social Security push could have a substantial upside for his party in
future elections. Hispanics and blacks are more heavily reliant on
Social Security income in their retirement, tend to hold lower-paying
jobs without employer-sponsored pensions, and own fewer assets than
their white counterparts, researchers say. Like young people … minority
voters are disproportionately supportive of the concept of expanding
ownership. …

But, from the same article:

Some
analysts who study minority voters say Bush's arguments are not
resonating with them … "This whole campaign of his has been an utter
flop. ... with African-Americans ..." said David A. Bositis, senior
researcher at the Joint Center for Political and Economic Studies, who
specializes in black voters and their attitudes. Early in his Social
Security roadshow, Bush argued that creating private accounts that
could be inherited would especially benefit African-Americans because
of the shorter life expectancy for black men. Research shows, however,
that the disparity in life span comes mostly from higher infant
mortality and homicide rates of young black men, and that there is
little difference between the life expectancy of black and white
retirees. Many blacks found Bush's argument "insulting," said Rep.
Kendrick B. Meek, a Florida Democrat who is leading his party's efforts
to turn young people against the Bush plan. "In the past when
[Republicans have] reached out to groups of color and young people,
it's always been for political reasons, and this time it seems like
it's no different," Meek said.

I've discussed whether the Bush-Pozen proposal is a better deal for younger workers here, so perhaps this demographic will see through the smoke and mirrors as well.

UPDATE: Here is part of Bush's press conference today. There appears to be an attempt to gain precisely the type of political advantage discussed in the article:

Q
Thank you very much, Mr. President. Sir, most Democrats continue to
refuse to negotiate with you on Social Security until you take payroll
tax-funded personal accounts off the table. Would you insist on these
accounts if it means no deal on Social Security?

THE PRESIDENT:
… except you got a President who's willing to talk about the issue --
and a President who, by the way, is going to keep talking about the
issue until we get people to the table. I repeat to you, Keith, the
Social Security issue is a really important issue for an upcoming
generation. I mean, imagine realizing that we got a problem and then
not doing anything about it, and watching a young generation get taxed,
perhaps by as much as a payroll tax of 18 percent. How would that make
somebody feel? That we shirked our duty, that we weren't responsible
citizens…the President has got to push. He's got to keep leading. … One
thing is for certain: The party that I represent is leading. … And so I
think as people make their calculations, that I think the American
people are going to end up saying to those who have been willing to
lead on the issue and talk about the issue and be constructive on the
issue, thanks for what you're doing and we'll send you back up there
with our vote, because that's the kind of spirit we like...

The Washington Post has an editorial supporting progressive indexing. But, as we shall see, Bob Ball has other ideas. Who is Bob Ball?

A Retiree Trying to Save His Life's Work, By Joel Havemann, LA Times:
… Ball's goal isn't preservation of his monthly benefit check. Instead,
he is defending the program that is his life's work. Before the first
monthly Social Security check was delivered in 1940, he was already
working as a 25-year-old clerk in the Newark, N.J., Social Security
office for $1,620 a year. He shot up through the bureaucracy to become
commissioner of Social Security for three presidents. On his watch,
Social Security became the biggest and most popular benefits program.
And in 1983, when he had been collecting retirement benefits for four
years, he was a key negotiator of the law that rescued Social Security
from the brink of insolvency. With the possible exception of J. Edgar
Hoover and the FBI, perhaps no one has been associated with a federal
institution as intimately and for as long as Robert M. Ball. He is one
of the last of a nearly extinct species: career civil servants who
became top policymakers…

First, here’s what the Washington Post says:

Mr. Bush's Proposal, Washington Post:
Is President Bush advocating cruel cuts in Social Security? … Tying
initial benefits to wage growth lets retirees share in the improved
standards of living to which they contributed. But because wages
generally increase faster than the cost of living, wage-indexing is
also enormously costly … Simply switching from wage- to price-indexing
would more than take care of Social Security's solvency problem. … Such
a formula wouldn't entirely eliminate the Social Security deficit, but
-- under a plan produced by investment executive Robert Pozen and
endorsed by Mr. Bush -- it would address about 60 percent of the
problem. The major critique of the Pozen plan is that promised benefits
for the middle tier would be cut too sharply. ... Mr. Pozen is the
first to say his plan could be recalibrated to be more generous to the
middle class. … there's not enough money in the system to pay scheduled
benefits, and tax increases can't be expected to cover all of the
shortfall, … It's why progressive indexing ought to be considered as
part of the solution.

What does Bob Ball think of this? Not much. Continuing with theLA Times story:

Like
many other retirees, Bob Ball is concerned about what's going to happen
to Social Security. From his cluttered office … he has proposed his own
formula for shoring up Social Security's financial future. His
relatively modest tax increases and benefit cuts, combined with some
government investment in the stock market, offer a contrast to
President Bush's call for individual investment accounts, which Ball
abhors, and steeper curbs on traditional benefits for many future
retirees. … [T]he proposals of … George W. Bush, have prompted the
91-year-old Ball to ... fight proposals that, in his view ... "would
ruin the whole system," ... "It's a fundamental, philosophical policy
shift." President Franklin D. Roosevelt, Ball said, wanted a
government-provided benefit that would replace a fixed percentage of a
workers' pre-retirement income. The vision was of a benefit based not
on need — which would carry the stigma of a welfare program — but on
past earnings. … Bush's suggestion that benefits be reduced from
now-promised levels for future middle-income and wealthier retirees ...
would eventually leave all with about the same benefit now promised to
the poor… The result, he said, would be a loss of political support for
Social Security.

Ball has his own proposal, which includes
dedicating the proceeds of the estate tax to Social Security and using
a more precise — and stingier — measure of price inflation to determine
annual cost-of-living adjustments. His most controversial proposal: let
the government invest some of the Social Security trust fund's surplus
in stock index funds. ... He hopes some Democratic lawmakers, who are
refusing to deal with Bush as long as he is pushing individual
accounts, will turn to his alternative when the time comes. … This is
not the first time that Ball has come out of retirement to advance
ideas for bolstering Social Security — and the last time, he carried
the day. In 1983 … Ball was a central figure behind a bipartisan
package to keep Social Security from running out of money — a prospect
then only months away. … Legend has it that when a bipartisan
commission deadlocked, President Reagan, a Republican, and House
Speaker Thomas P. "Tip" O'Neill (D-Mass.), decided that Social
Security's future was more important than partisan advantage. So the
two Irishmen met alone and agreed to a rescue package. Fiction, says
Ball. "Reagan and O'Neill couldn't stay in the same room together," he
said. The deal was negotiated largely by Ball …Commission members
quickly agreed that the final package had to include tax increases …
and benefit cuts … When that didn't add up to enough cost savings, Ball
hit upon an innovative step that could be interpreted by Democrats as a
tax increase or by Republicans as a benefit cut: subject some Social
Security benefits to the income tax. Reagan and O'Neill signed off on
the deal, and Congress passed the accord handily.

… Ball … was
appointed commissioner of Social Security ... in 1962, a job that he
held ... through … the first term of Republican Richard M. Nixon. In
1972, when he was running for reelection, Nixon supported a 5% benefit
increase along with a long-time goal of Ball's — automatically
adjusting benefits in future years to keep pace with inflation.
Congress kept the inflation protection … Chuck Colson got the idea of
including in the envelope with the first beefed-up Social Security
check an insert crediting Nixon with the increase. Ball threatened to
quit and, by implication, go public with the reason, if the White House
took this unprecedented step. The White House backed down. Nixon
replaced Ball the next year. … That was three decades ago. Ball has
outlived many of the presidents for whom he worked. … And, if anyone
cares to listen, he has a long view and a few more ideas about Social
Security to share.

"Why
should the U.S. care for the rest of the world?" he asked. "The U.S.
should take care of its own. ... It's way past time for liberal twits
to stop pushing the U.S. into nonsense or try to make every wrong in
the world our responsibility."

And while that
reader wasn't George W. Bush, it could have been. Today marks Day 141
of Mr. Bush's silence on the genocide, for he hasn't let the word
Darfur slip past his lips publicly since Jan. 10...

I
live in Eugene, Oregon, one of the few places in the country where
Democrats made gains in last November’s election. Eugene, Oregon, the
place where flower children come when Berkeley has offered it's full
plate of liberal fare and it's not enough. This (scroll down) is more typical of the Eugene I know:

Eugene Oregon, a liberal blogger, and Feddie, a conservative blogger, started a group blog called Coalition for Darfur. If you haven't seen it, or haven't been keeping up with Eugene Oregon's (of the blog Demagogue) coverage of the crisis in Sudan, then you are missing out on much of the story.

Monday, May 30, 2005

Teamsters President James Hoffa makes a political calculation and decides to switch sides:

Reform prod by Hoffa, By Donald Lambro, Washington Times:
Breaking with the Democrats and AFL-CIO on Social Security, Teamsters
President James Hoffa Jr. sent a message to the White House … that he
wants to help them find a bipartisan solution to the programs long-term
insolvency. Mr. Hoffa not only generously praised George W. Bush … he
faulted Democrats for refusing to come to the table until the president
drops his personal retirement accounts plan. … Republicans will be in
charge … for the next four years, and Mr. Hoffa now thinks he can work
with the GOP …

Is this a sign of the beginning of a push for a flat tax? I find it
interesting that Stephen Moore of the Free Enterprise Fund and the Cato
Institute holds up Estonia, Albania, and Russia as examples of the
economic miracles available with a flat tax:

Freedom to choose flat tax, By Stephen Moore, Washington Times:
All over the world, from Estonia, to Albania, to Russia to Hong Kong,
flat taxes are in vogue. The flat tax is being instituted to enhance
economic growth, increase tax revenues and make tax codes fairer. …
isn't the world topsy-turvy when Moscow, the onetime center of
socialism, has a 13 percent top income tax rate compared to 35 percent
in America, the land of the free? … I …suggest … adoption of a Freedom
to Choose Flat Tax. …

Yes, let’s strive to emulate the
economies of Estonia, Albania, and Russia – as the administration’s
current economic policy seems to be doing…

When the latest data on unemployment, GDP, industrial production, and
so on are released lots of attention is generated in the press, the
blogosphere, and elsewhere. With the release of each new piece of
information we hear the economy is headed towards recession or moving
towards full employment depending upon who is doing the reporting and
what piece of information is being reported. When measures of aggregate
activity disagree, which measure should be given more weight? Does it
matter which measure of aggregate activity is used to measure the state
of the economy? Let’s start by looking at graphs of commonly used
measures of aggregate activity.

Here are three measures of
aggregate economic activity, the deviation of unemployment from its
natural rate, the deviation of GDP from its natural rate, and the
deviation of industrial production for its natural rate. Thus, there
are three gaps, an unemployment gap, an output gap, and an industrial
production gap. All are measured in real terms. The first two are
created using the estimates of the natural rate of unemployment and
output from the Congressional Budget Office, and the last is derived
from a measure of the natural rate of industrial production I created
using the natural rate of GDP from the CBO (I was curious to see how
well it would correspond to the other two more commonly used measures).
The measures are rescaled to make it easy to graph them on the same
vertical scale. The first graph shows the unemployment and output gaps,
and the second shows the unemployment and industrial production gaps:

What do we learn? Here are some broad conclusions:

1.
Over the long-run, there is very little difference in the underlying
trend movements in the three measures. This shows that general trends
in aggregate activity are evidenced fairly well by examining general
trends in all these series, i.e. by examining the average movement
across a variety of measures of activity over many quarters.2. But
what if recent data for the last quarter or two differ? For example,
suppose the output gap is falling but the unemployment gap is not. In
this case, the output gap movement might command more attention than
the stagnant unemployment gap, though not too much should be made of a
single observation in any case. A close examination of the first graph
(and something more sophisticated empirical investigation verifies)
shows that turning points in the output gap tend to lead turning points
in the unemployment gap. Thus, data indicating a turning point in
output without a corresponding turning point in employment are worth
more attention than the opposite situation, a change in the
unemployment gap not evidenced in the output gap measures. There also
appears to be a similar lead-lag relationship between the industrial
production and unemployment gaps, but it is not as evident as with the
output gap. In addition, it is interesting to note that the lag in the
unemployment gap relative to the output gap seems more pronounced since
1990.3. While the three series move closely in the long-run, there
is considerable variation across the three measures in the short-run.
Thus, the current situation we are seeing in the data – monthly or
quarterly data that appear confusing – is normal. Averaging the
information content of the three measures both in the current time
period and over time (and, of course, taking account of lags in
relationships as well as other available data) will improve the picture
when recent measures disagree as to the direction the econoomy is
headed.

Sunday, May 29, 2005

I started reading The Fed is all wrong about inflation, by Jim Jubak in MSN Money
thinking it would be an informative article about the Fed, inflation,
and monetary policy. I’m not sure why I bothered to finish reading it
after encountering statements such as:

... “An increase
in the money supply kicks in to drive inflation higher after the
initial demand-based inflation has set prices in motion. Governments
typically attempt to combat rising prices by increasing the amount of
money in circulation. …”

It gets worse. Economic crises are
caused by 80-180 year "price waves." Even simple concepts such as real
and nominal prices are confused by their "expert." Don’t waste your
time on this one…I've listed much better reading in the post below the next one.

Why has the dividend payout ratio increased in recent years? According
to the article below, there are several possible reasons: (1) Concerns
about future returns. When investors expect the market rate of return
to exceed the internal rate of return for the firm, they would prefer
to have dividends paid out instead of reinvested internally. Thus, as
investors anticipate lower rates of return in the future, they will
shift towards firms offering dividends and away from firms that use
profits for internal reinvestment. (2) The tax act of May 2003 made
dividends relatively more attractive from a tax perspective. (3) A
change in corporate compensation law has led to a restructuring towards
compensation packages that rely more heavily on dividends. (4) There
has been a recent shift by investors towards assets with less risk, and
historically firms with both solid growth and yield characteristics
have less risky overall returns.

Besides the changes in tax law,
there are two notable changes causing the shift towards dividends. The
first is the fall in expected growth opportunities which causes the
fall in expected rates of return. To the extent that the shift has been
driven by investor’s perception of slower growth in the future, that is
not a postiive sign for the economy. The second is the shift towards
less risky assets. This may also signal uncertainty regarding future
economic conditions. As noted below, historically firms with a history
of solid growth and dividend payments have returns, as you would expect
from their general health, that perform well in volatile markets. Thus,
these types of firms provide a degree of insurance against uncertain
future returns. Here's the story from the AP:

Dividend-Paying Stocks May Lead a Trend, By Meg Richards, AP:
The emerging leadership of dividend-paying stocks has … renewed
interest in what was once considered an old-fashioned investment.
Dividends … The dividend revolution is most clear in the technology
sector, where they've grown at a rate of 44 percent over the past two
years. ... Historically, dividends have played a much more important
role than they currently do, accounting for about 4 percentage points
of the roughly 10 percent average annual return stocks have delivered
since 1926. But their popularity waned during the bull market, and …
struck an all-time low of 1.1 percent in 2000. ... Now that number has
climbed to …1.9 percent. The rate of payout has been on the rise, as
well …

… some of this [is due] to the tax act of May 2003, which
lowered the rate for long-term capital gains and qualified dividends to
15 percent … Prior to that, dividends were taxed … at rates as high as
35 percent. … Why now, two years after the tax act was passed, are
dividends taking the lead? … One of the reasons for the recent pullback
in stocks was investors' concerns about earnings growth. … Another
factor is the rush to restructure compensation packages before the end
of the year, when corporations will be required to start expensing
stock options at fair value. … On top of that, research suggests
high-quality companies with both growth and yield characteristics are
poised to produce market returns with meaningfully less risk. They're a
safe place to seek shelter when volatility strikes… They've also
performed well historically, …

Pelosi Moves From 'No' to 'No Dice' on Social Security Reform, Susan Jones, Morning Editor, (CNSNews.com):
… House Minority Leader Nancy Pelosi and other Democrats have said no
all along, but now they're saying "no dice" to President Bush's call
for change. Pelosi repeated the "no dice" phrase multiple times at a
news conference on Thursday. She also condemned the "poison pill of
privatization" and announced that Democrat lawmakers would testify
against personal accounts for younger workers before a House
subcommittee on Social Security … Pelosi accused President Bush of
creating a crisis and manufacturing an issue. … 'Remove the poison pill
of privatization, and Democrats will come to the table with our ideas '
…

Stupak addresses Social Security concerns, By Pete Mackin, Mining Journal:
… Rep. Bart Stupak, D-Menominee … said that he supports getting people
to save more, but reiterated he will not support privatizing Social
Security. "If this is his (Bush's) goal, a thrift savings plan - if the
idea is to get people saving, I'd say that's a great idea," Stupak
said. "But I cannot support a plan that slashes benefits, saddles the
next generation with trillions of dollars in debt, and introduces risk
into the only guaranteed income on which our retirees can depend upon."

With
Democrats unwilling to negotiate until the insistence on carve out
private accounts is dropped, and Republicans unwilling to take private
accounts off the table, the result, for now, appears to be gridlock:

Lawmakers argue over Social Security changes, By Larry Lipman, Palm Beach Post Washington Bureau:
A parade of lawmakers Thursday touted their views of how Social
Security should be restructured, with Republicans offering a variety of
private account proposals and Democrats warning they would oppose any
plan that undercut the current system. … Rep. E. Clay Shaw Jr., R-Fort
Lauderdale… said … "To tell the president that he has to drop his plan
before the Democrats will talk to him, that's ludicrous," … "You're not
going to be with us on the landing if you're not with us on the
takeoff," … But Rep. Benjamin Cardin, D-Md., shot back: "I'm not so
sure I want to be there on the takeoff if you're going to have a crash
landing."…

Partisan clash stalls progress on Social Security, by Carolyn Lochhead, San Francisco Chronicle Washington Bureau:
A key Senate Republican conceded Wednesday that he has made little
progress crafting a Social Security overhaul. Asked how close he is to
coming up with a legislative package, Finance Committee Chairman
Charles Grassley replied, "Not very close, I'm sorry to say. We have
not made a lot of progress in the three meetings we've had with our
members." … Sen. Max Baucus of Montana, the Finance Committee's top
Democrat, said he will not negotiate until Bush abandons his support
for private accounts. Grassley burst out in frustration after
Wednesday's hearing. "The most obvious thing you heard today is that on
the Democratic side of the aisle, it doesn't matter what you put out,
what you talk about, there's no plan on the other side, and there's
constant criticism," Grassley said. … Baucus slammed Bush's proposed
benefit changes as "drastic." … After the hearing, Baucus said, "The
linchpin here is private accounts. Once they're off the table, I think
there would be a huge, or a significant, groundswell for trying to find
a solution." [National Economic Council director Al] Hubbard refused to
say whether Bush will accept a proposal without individual accounts
funded by Social Security payroll taxes. "We see no reason why people
shouldn't be given that option," Hubbard said. But he also said the
administration is receptive to the "add-on" individual accounts
Democrats favor. … It appeared more than ever after Wednesday's Senate
hearing that Bush's hopes on Social Security rest with House Ways and
Means Committee Chairman Rep. Bill Thomas, R-Bakersfield, who is
crafting a much more sweeping plan aimed at "retirement security."
Thomas is looking at a wide range of tax, health care and other changes
in addition to Social Security in the hope of luring Democrats.

Some
also believe Bush's hopes on Social Security rest with the gang of
fourteen. Will the gang reassemble to try and overcome Social Security
reform gridlock?:

Social Security is next for Gang of Fourteen, By Jackie Kucinich and Jeffrey Young, The Hill:
Some of the senators who banded together to forestall the “nuclear
option” are eyeing a new goal: reforming Social Security. … Sen.
Lindsey Graham (R-S.C.) wasted little time in touting the group’s
clout. ... “Watch this group of 14 to come out with some deal for
Social Security.” “Really?” said Matthews. Graham responded, “Keep
watching.” … Sen. Olympia Snowe (R-Maine) … and Sen. Joe Lieberman
(D-Conn.) have been working together on developing a Social Security
plan under the auspices of the Centrist Coalition, … Sen. Lincoln
Chafee (R-R.I.) strongly believes that Senate centrists would be the
architects of Social Security reform, according to an aide. “My boss
has been saying that from the beginning,” the aide said. Chafee has
been cooperating with the efforts of Snowe and Lieberman, he added. …

Until
the administration puts a reasonable proposal on the table, and so far
that hasn’t happened, gridlock is a reasonable response. A better
outcome would create voluntary add-on accounts that simultaneously
increase retirement security and increase national saving. But that
won’t happen until the administration is ready drop its insistence on
carve out personal accounts as an element of any reform proposal,
something it has not yet indicated it is ready to do. It's possible
that a centrist coalition could produce this outcome, but I worry that
Democrats in such a coalition might ignore Rubin's advice and
compromise on carve-out private accounts in an effort to show progress
to constituents as a means of furthering political and other
aspirations.

... I served with Jack Kennedy, I knew Jack Kennedy, Jack Kennedy was a friend of mine. ... you are no Jack Kennedy ... [1988 Vice Presidential Debate]

Theodore C. Sorensen, former special counsel to President Kennedy, offers wise advice to our leaders using words from the past:

What JFK might tell our leaders, by Theodore C. Sorensen, Boston Globe:
Tomorrow would have been John F. Kennedy's 88th birthday. Were he still
alive, I have no doubt that, with his customary idealism and commitment
to country, he would still be offering advice to our current leaders in
Washington. Based upon his words of more than 40 years ago, he might
well offer the following:

To President George W. Bush on Iraq, Iran, and North Korea:
''The United States, as the world knows, will never start a war. This
generation of Americans has had enough -- more than enough -- of war."
(American University commencement, 1963)

To President Bush on stem cell research:
''For those of us who are not expert ... we must turn, in the last
resort, to objective, disinterested scientists who bring a strong sense
of public responsibility and public obligation." (National Academy of
Sciences, 1961)

To Vice President Dick Cheney on international organizations, alliances, and consultations:
''The United States is neither omnipotent nor omniscient. We are only 6
percent of the world's population . . . we cannot impose our will upon
the other 94 percent of mankind." (University of Washington, 1961)

To Secretary of State Condoleezza Rice on terrorism: ''If a free society cannot help the many who are poor, it cannot save the few who are rich." (Inaugural address, 1961)

To United Nations ambassador-designate John Bolton on diplomacy:
''Civility is not a sign of weakness. The United Nations [is] our last
best hope in an age where the instruments of war have far outpaced the
instruments of peace." (Inaugural address, 1961)

To Defense Secretary Donald Rumsfeld on space:
''We have vowed that we shall not see space filled with weapons of mass
destruction, but with instruments of knowledge and understanding. This
new ocean must be a sea of peace, [not] a new terrifying theater of
war." (Rice University, 1962)

To House Majority Leader Tom Delay on fund-raising:
We need ''men of integrity whom neither financial gain nor political
ambition could ever divert from the fulfillment of our sacred trust."
(Massachusetts farewell, 1961)

To Senate Majority Leader Bill Frist on judges:
''To maintain the constitutional principle, we should support Supreme
Court decisions, even when we may not agree with them." (News
conference, 1962)

To White House Press Secretary Scott McClellan on negative news media:
''It is never pleasant to be reading things that are not agreeable
news, but it is an invaluable arm to the presidency as a check on what
is going on . . . [e]ven though we never like it . . . and wish they
didn't write it . . . we could not do the job at all in a free society
without a very, very active press." (Television interview, 1962)

To pastor-in-chief Pat Robertson on church-state separation:
''I believe in an America where no [clergyman] would tell his
parishioners for whom to vote, where no religious body seeks to impose
its will directly or indirectly upon the public acts of our officials,
where no church or church school is granted any public funds or
political preference. The presidency must not be the instrument of any
one religious group." (Houston ministers, 1960)

To Undersecretary of State for Public Diplomacy Karen Hughes on propaganda:
''The United States is a peaceful nation where our strength and
determination are clear, our words need merely to convey conviction not
belligerence." (undelivered Dallas speech, 1963)

Friday, May 27, 2005

BusinessWeek Online’s Michael
Wallace speculates on Greenspan’s successor. One possibility discussed
is that Greenspan will stay on for as long as two and a half more years
as the administration ostensibly searches for a replacement. As
tempting as this might be from a financial stability point of view, I
believe that the Federal Reserve is too important of an institution to
have its rules set aside through a political maneuver to allow
Greenspan to exceed the intended fourteen year term. Rules intended to
be used in extraordinary circumstances are not the appropriate means to
extend the normal term of a Federal Reserve Board member. Here is BusinessWeek’s discussion of Greenspan’s likely successor:

BusinessWeek Online: Who Will Fill Greenspan's Shoes?, by Michael Wallace:
… Federal Reserve Chairman Alan Greenspan is due to retire on Jan. 31,
2006. … Who will be his successor? Technically, the chairman could
still get a request to stay on for a spell by the Bush Administration,
which is searching not only for his replacement -- potentially
extending his tenure another 2.5 years -- if no replacement is put
forward.

FELDSTEIN IN FRONT. … Most discussions about
Greenspan's succession begin with … Martin Feldstein, ... But the
seeming rush to get former Fed Governor Ben Bernanke installed as head
of the President's Council of Economic Advisers (CEA) … has sparked
rumors of his possible candidacy for chairman. Glenn Hubbard, …
probably ranks as the third-leading candidate for the Fed post …

"OUTSPOKEN
DOVISHNESS." … As an academic economist and monetarist, [Bernanke]
shaped the policy debate on deflation risks that helped spur the
decision to slash benchmark interest rates to 1% ... His outspoken
dovishness on inflation during this period would qualify as a feather
in his cap insofar as his backers are concerned.

Yet his stated
preference for inflation targeting … as do the Bank of England and
European Central Bank -- risks asserting hard numbers over rationality,
rendering him a risky choice for the Administration. His relatively
vocal prior policy positions could potentially limit his flexibility in
steering the Fed's more progressive risk-management approach, as was
seen under Greenspan, and might reduce his internal bargaining power
over policy choices.

RISKY REMEDY. Bernanke came to the Fed
Board via Princeton University, …Independence is his greatest strength,
and perhaps his greatest liability. This is best illustrated by his
appointment of Paul Krugman to the faculty at Princeton …

Feldstein
and Hubbard have liabilities that may overshadow their considerable
qualifications as well. …Feldstein, as CEA chairman under President
Reagan … committed the politically treacherous act of proposing a dual
remedy of raising taxes and cutting spending. Feldstein has since
fallen back to the position that the present deficit is a much smaller
percentage of GDP than was the case in the Reagan years. Still, his
previous outspokenness … may mark him as a risky candidate. Hubbard
appears to have acted as a staunch defender of Bush tax cuts and
downplayed fiscal risks, which will not endear him to Democrats.

HONORABLE
MENTIONS. Fed Governor Donald Kohn has also received honorable mention
… but his status as a longtime Fed insider and right-hand assistant of
the chairman perhaps makes him too much his own man at the Fed. …Other
honorable mentions go to former Fed Governor Larry Lindsey and John
Taylor of the Treasury, … likely the darkest horses in this race. Then
again, some observers saw Greenspan himself as something of a long shot
before his first appointment to the top Fed post. …

The Long Wait for a Housing Slump, By Kathleen Madigan, BusinessWeek Online:
Alan Greenspan's "conundrum" has been the housing sector's savior. …
With no cooling in sight … why hasn't the big chill happened yet? It
all comes down to mortgage rates, which have not risen as expected. …
The drop in bond yields is unusual given the economic circumstances.
Even Fed Chairman Greenspan has admitted the bond market's behavior is
a riddle.

… Policymakers have already noticed that ... higher
energy costs ... has pushed up core inflation ... Normally, the Fed's
tightening and inflation fears would be pushing up bond yields.
Instead, traders seem to hold ... that ... the economy might be done
growing, and so the Fed likely is just about finished raising rates
this go-round. Moreover... the drop in bond yields may not be saying
anything much about the U.S. economic outlook. A glut of global savings
is chasing yields, and right now even a paltry 4% payout on U.S.
Treasuries beats the 3.5% or less to be gotten from euro bonds. In
addition, the central banks of China and other Asian nations are buying
dollar-denominated assets to prevent their currencies from appreciating
…

Despite low bond yields, Fannie Mae's chief economist, David
Berson, offers some reasons a slowdown in housing is still a good bet.
First, rising prices make affordability an issue for many buyers.
Second, the rates of 2003 and 2004 -- the lowest in a generation --
induced some households to buy. That pulled forward sales which
otherwise would have taken place in 2005. … regulators are trying to
crack down on too-easy standards for home-equity loans. At the end of
the day ... a housing slowdown will depend on an attitude change in the
bond market. And while market sentiment can turn on a dime, there are
no signs right now that traders will pushing rates up soon.

Here are Fed Governor Bies' remarks on the conundrum along with a summary of other remarks by Federal Reserve officials from a Reuter’s report:

Fed officials leave hikes in little doubt, By Ros Krasny, Reuters:
Federal Reserve officials left little doubt on Thursday that the bank
has more rate increases in mind .. the Fed's program of "measured"
increases in short-term rates, Chicago Fed President Michael Moskow
said the bank's policy remains accommodative. Separately, Atlanta Fed
President Jack Guynn said the Fed has "not yet reached a neutral policy
stance." Fed Gov. Edward Gramlich, speaking in Paris, said the measured
rate increases could continue. … Moskow stayed close to the Fed's
central message. "We can continue to remove monetary policy
accommodation at a measured pace," he said. …

Federal Reserve
Governor Susan Bies took on the "conundrum" of low long-term U.S.
interest rates in comments to reporters after speaking at a Women in
Housing and Finance event in Washington …."I honestly don't know what
it's going to take. It just appears that long-term rates cannot stay at
this low level," Bies said.

The long rates puzzle dovetails into
another worry for policy-makers, a hot housing market that has recently
attracted the kind of speculative cash associated with stock market
bubbles of yore. Officials repeated concerns about real estate
speculation but once again stopped short of tagging the current
situation a "bubble." … "At some point we do believe that the 10-year
Treasury (note yield) will rise above 4 percent and take mortgage rates
with it," Bies said.

Finally, Bloomberg’s Caroline Baum weighs in:

Yield Curve, More Than Shapely Body, Has a Brain, Caroline Baum, Bloomberg:
… The yield curve, or the pictorial representation of the yields on
Treasury securities across the maturity spectrum, has … narrowed, to
the point that it's creating a source of consternation … With every
indication that the Fed plans to proceed with its agenda of rate
increases and every sign that long rates aren't going to budge in
response (at least not higher), it's possible the curve could invert
before too long. An inverted yield curve, with short rates higher than
long rates, is typically a harbinger of recession. ... Not this time. …
Fed officials aren't contemplating implementing a contractionary
monetary policy. So what are we to make of the dramatic flattening of
the yield curve? … The yield curve is a simple construct that's widely
misunderstood. … I've craft[ed] a primer on the yield curve. For the
purposes of this discussion, the yield curve will connote the spread
between the overnight federal funds rate and 10-year Treasury note
yield.

1. What's so special about two yields among thousands? …

What's
special is the information provided by the interaction between the two
rates: one set by the central bank, the other by the market. While long
rates are influenced by short rates … they're also affected by real
activity and inflation expectations, not to mention a myriad of
political and psychological considerations. The long rate is a window
into the stance of policy.

2. My windows need washing. What do you mean by the interaction between them?

…
Most [central banks] use an overnight or other short-term rate as a
policy tool. The monetary authority provides whatever reserves the
banking system demands to achieve its target rate. If the central bank
is holding the short rate steady, and market rates are rising, it's a
pretty good indication that the overnight rate is too low. … Because …
the demand for credit is rising faster than the Fed can supply it.

3. Who figured this stuff out?

The
theory behind the yield curve's role in anticipating economic growth
and inflation can be traced back to the late Swedish economist Knut
Wicksell (1851-1926). Wicksell argued that when the rate at which banks
lend is below … the natural rate of interest, prices would rise. When
the bank rate exceeds the natural rate, prices would fall.

4. How do I know what the natural rate of interest is?

You
don't. It's unobservable. Which is why the interaction between the two
rates provides … information ... Think of the long rate as a check on
the central bank. If policy is too easy or too tight, it will send up a
flare.

5. Now I'm really confused. How can falling long rates be
a negative? Isn't there more incentive to borrow at 5 percent than 6
percent?

Yes. And that's one part of the story. If you only
looked at the level of long-term rates, the Great Depression should
have been the Great Boom, and Japan's lost decade should have been
Paradise Regained. In both cases, low long-term rates were a symptom of
weak economic growth, not a cause of stronger growth in the future. …

6. Low mortgage rates have created a boom in housing. How can you say a flatter yield curve is less stimulative? …

…
Ceteris paribus, declining mortgage rates make home ownership more
affordable. In the micro world of housing, credit demand is strong. ...
Whether it's Asian central banks or private investors wanting a
risk-free investment, more people are choosing to save in dollars,
which is pushing down long-term rates….

Thursday, May 26, 2005

Here is a video of the hearing on the nomination of Ben S. Bernanke, of
New Jersey, to be a member of the Council of Economic Advisors and the
nomination of Brian D. Montgomery, of Texas, to be Assistant Secretary
of Housing and Urban Development:

CSPAN Video: Hearing on Nomination of Ben Bernanke for Council of Economic Advisers and Nomination of Brian D. Montgomery to be Assistant Secretary of Housing and Urban Development (05/25/2005):

This article discusses the decline in income mobility in recent decades
and asks if the US “… is becoming less of a meritocracy, where skill
and intelligence determine success, and ... more of a class-bound
society…”:

The American Dream gains a harder edge, By David R. Francis, CSMonitor.com:
The American dream, at least on the economic side, is fading. … Today …
nearly 1 in 5 American households has zero net worth or actually owes
more than it owns. And the odds of a son or daughter rising above their
parents in such a financial predicament have shrunk. "Income mobility
has declined in the last 20 years," says Bhashkar Mazumder, an
economist at the Federal Reserve Bank of Chicago. What that means is
that the US is becoming less of a meritocracy, where skill and
intelligence determine success, and becoming more of a class-bound
society, where economic background, including the better education
money can provide, matters more. … Most Americans don't believe that to
be true, surveys show. But academic studies suggest that income
mobility in the US is no better than that in France or Britain. It's
actually lower than in Canada and is approaching the rigidity of
Brazil. That marks a change from the past… From 1950 to 1980, Americans
were more and more likely to see their offspring move up - or down -
the income ladder. … Today, it could take five or six generations to
close the gap between poverty and middle-class status, calculates Mr.
Mazumder. …

Here’s a sophisticated analysis of Fed policy from The New York Post telling us that it's bad when bad things happen to a bad economy:

Fed Rate Hikes Could End Badly, By Roddy Boyd, NY Post:
If Ed Hyman is right, things are likely to get pretty ugly on Wall
Street in the not-too-distant future. The top economist has started
telling clients that the Federal Reserve's tightening cycle is almost
certain to end badly. Assigning a 70 percent probability to the
likelihood of a calamity this year, he argued that every Fed interest
rate increase cycle since 1970 has involved at least one high-profile
financial calamity. Without pointing a finger at likely targets, Hyman
said the end of the Fed's tightening is an indication of the slowing
growth of the economy, which alone often exposes economic weaknesses.
These weaknesses, combined with some type of spectacular scandal could
ignite a downturn.

Setting aside the question of how he
calculated a 70% probability for a “calamity” (one of the nice things
about pulling numbers out of a hat is that you don’t have to define
terms such as calamity or spectacular scandal – note that he wouldn’t
identify any potential events falling into this category), we are told
that the Fed will ease monetary policy when growth slows, that slow
growth indicates the economy is weak, and if some undefined spectacular
scandal or calamity hits a weak economy that could be a problem. Wonder
how much the “top economist” charged his clients for that advice.

[Update:
The feedback on this post suggests I should have focused on the
reporter and not the analyst ... I've had my remarks filtered and
misrepresented by copyeditors and reporters so I'm sympathetic to that
view ...]

Bloomberg.com discusses Bernanke’s Senate
confirmation hearing, the opportunities and pitfalls that come with
appointment as Chair of the White House Council of Economic Advisers,
and how Bernanke’s past outspokenness might be problematic:

Bernanke's Outspokenness at Fed Faces Test in White House Job, Bloomberg:
Federal Reserve Governor Ben Bernanke is likely to win Senate approval
to take over the White House Council of Economic Advisers, a job that
has been a stepping- stone to the Fed chairmanship and a political
minefield. … Bernanke … will be taking on a role that once was filled
by Fed Chairman Alan Greenspan. Others, including Harvard economics
professor Greg Mankiw, … ended their tenure with political scars and
diminished chances for higher government posts. It's a job … where
strong ideas frankly expressed don't guarantee success. … In a career
in academia and as a Fed governor, Bernanke, 51, has rarely displayed
uncertainty about economics. At the Fed, … Bernanke publicly disagreed
with Greenspan on numerical goals for inflation. … Bernanke is willing
to buck fellow economists, as well. … [Link to article]

There is very little good news for president Bush in a new CBS poll.
More than half the respondents disapprove of the job he is doing as
president, the numbers are even worse on his handling of economy, and
he is increasingly viewed as out of touch. In addition, only 26 percent
approve of his handling of Social Security, there is continued doubt
about his plan to partially privatize Social Security, and “Most of
those who have heard a lot about the President’s plan say allowing
individual investments of Social Security taxes is a bad idea.” [Link to CBS article and poll results]

Wednesday, May 25, 2005

Following up on PGLs post at Angry Bear, here are more quotes from George "I'm a uniter, not a divider"
Bush who has a message for anyone so daring as to question the
assumptions used by the administration to create a solvency crisis and
hence the need for reform, or anyone who might stand in the way of his
philosophical vision for Social Security:

"There are
some good ideas that I put on the table" that Congress has been
reluctant to engage. ... Bush warned lawmakers that increasing numbers
of Americans are getting the idea that the nation's retirement system
is on an unsustainable fiscal course and said politicians must step up
to solve the problem. "Those who obstruct reform, no matter what party
they're in, will pay a political price ...

Here's my
worry in the days ahead. The success of moderates in averting
congressional meltdown over filibusters may tempt them to ride their
wave of momentum into the Social Security arena. In doing so, they may
be overly eager to show they can get things done to further their
political aspirations. This may yield far too many concessions, in
particular carve-out private accounts, in an attempt to gain
cooperation.

[Note: The linked quote "I'm a uniter, not a divider" is from an interesting 1999 interview at Salon prior to Bush's nomination for president.]

This article describes the rising college drop-out rate, particularly
among lower income students, and the widening education gap this is
bringing about. The article also looks at potential causes of the
rising dropout rate and policies attempting to reverse the trend:

The College Dropout Boom, By DAVID LEONHARDT, NY Times:
…One of the biggest decisions Andy Blevins has ever made, and one of
the few he now regrets, never seemed like much of a decision… He had
been getting C's and D's, and college never felt like home, anyway. ...
So he quit college … and … … joined one of the largest and
fastest-growing groups of young adults in America. He became a college
dropout … Only 41 percent of low-income students entering a four-year
college managed to graduate within five years … but 66 percent of
high-income students did. That gap had grown over recent years. … [continue reading…]

Tuesday, May 24, 2005

Thanks to Marginal Revolution for a link to a recent interview by Greg Mankiw in Fortune Magazine.
He discusses Social Security, Inflation Targeting, the deficit, Paul
Krugman, Karl Rove's role in policy, and other issues. The link has
excerpts from those sections of the interview. As Marginal Revolution
notes "Fascinating all around."

The Fed meeting minutes are out and for me
this paragraph summarizes their stance fairly well. If there is any
news, it is that the committee expressed a bit more concern over rising
inflation and inflationary expectations than I anticipated, though that
won't be surprising to everyone. There was also discussion of removing
the "measured pace" language, but since the statement is clearly
conditional upon future inflation, economic growth, and other economic
conditions the committee decided to retain the language. The message is
that any apparent change in the underlying trend for inflation or
growth (more than a few monthly reports indicating weakness or strength
in particular areas) could cause the Fed to deviate from the "measured
pace." Here is the summary paragraph:

Minutes of the Federal Open Market Committee, May 3, 2005:
… In the Committee's discussion of monetary policy for the intermeeting
period, all members favored raising the target federal funds rate 25
basis points to 3 percent at this meeting. Although downside risks to
sustainable growth had become more evident, most members regarded the
recent slower growth of economic activity as likely to be transitory.
In this regard, the ability of the U.S. economy to withstand
significant shocks over recent years buttressed the view that
policymakers should not overreact to a comparatively small number of
disappointing indicators, especially when economic fundamentals
appeared to remain quite supportive of continued solid expansion. To be
sure, the Committee had raised its federal funds rate target
appreciably over the past year, and, in the view of a few members, a
larger-than-expected moderation of aggregate demand in response to this
cumulative policy action could not be ruled out. However, all members
regarded the stance of policy as accommodative and judged that the
current level of short-term rates remained too low to be consistent
with sustainable growth and stable prices in the long run. Against the
backdrop of the recent uptick in core inflation and in some measures of
inflation expectations, members agreed that they should continue along
the course of removing policy accommodation at a measured pace
conditional on the outlook for inflation and economic growth…

There are those who won’t to give up on personal accounts even if
everyone else believes it’s time to do so. Pete du Pont is one of them.
Du Pont highlighted Social Security reform in his 1988 bid for the
Republican nomination for president, so it’s understandable why he
might hold on to the privatization idea longer than most. His
commentary today in The Washington Times tries to rescue private accounts from the administration’s sinking ship.

In
his remarks, he acknowledges that personal accounts do not help with
the solvency issue the adminstration claims exists. For that, he
suggests the Pozen-Bush plan to cut benefits. But he says there’s still
a positive aspect to privatization. If the government says "we are only
going to pay 80% of what we promised, you are on your own for the other
20%," then it will be easier for the government to meet its
obligations. By that logic, the government should privatize 100%
because then government provided benefits would be zero and it couldn’t
possibly have trouble meeting its obligation. What he doesn’t address
is the shift in risk to individuals that comes with the shift in
obligation to the private sector. When he says “PRAs offer the only
chance for younger workers to gain anything from reform” he ignores the
shift in risk to individuals. Opinion poll
after opinion poll has made it clear that the public is not willing to
accept the increased economic risk brought about by PRAs when they do
nothing to enhance benefits. Here are du Pont's remarks:

Essential element of reform, By Pete du Pont, The Washington Times:
Those who decide what is conventional wisdom inside-the-Beltway are
pushing the idea President Bush is losing support for his plan to
reform Social Security with personal retirement accounts and it is time
for him to cut his losses. The argument goes something like this:
"Since PRAs don't solve the solvency issue, they're not worth the
hassle." … some are beginning to question whether PRAs are a good idea.
… If personal accounts don't solve the problem, why are we talking
about them? The quick answer is PRAs were never meant to be a silver
bullet, but they are essential to any viable reform package. … Under
most reform proposals, PRAs do not shore up the solvency problems on
their own. …

However, saying they "do nothing" is entirely
inaccurate. … Over time, as workers with personal accounts retire,
Social Security's obligations are reduced. Thus, Bush-style personal
accounts alone will reduce Social Security's costs by about 10 to 15
percent over the next 75 years, and more than 20 percent beyond the
75-year horizon. Of course, Mr. Bush's approach includes more than just
adoption of PRAs. He has also noted the need for other measures, like
curbing the growth of future government-provided benefits. ... Adopting
both aspects, reducing government's burden and including PRAs will
provide benefits comparable to what the system now promises and more
than it actually can afford. … PRAs offer the only chance for younger
workers to gain anything from reform.

The word chance in
his final sentence is important. PRAs also offer younger workers a
chance to lose something from reform. Think of the person in the
example in the article who receives $1,200 per month from the
government and hopes to get $300 from personal accounts. The rate of
return assumed to yield that amount in the calculations, 3%, is
misleading. The 3% does not subtract off the clawback of 3% so the net
return is zero. It would take a return of 6%, not 3% as cited, to
achieve a net 3% return. The 4.6% return cited as the average return on
a 50-50 bond and stock portfolio is similarly misleading. Subtract the
clawback and the net return is only 1.6%. And this is an average
return, some will do better, others worse.

The article misleads
even further when du Pont states "PRAs will provide benefits comparable
to what the system now promises" while at the same time endorsing the
Pozen-Bush proposal to reduce benefits:

Mr. Bush recently
endorsed a proposal by a Democratic member of his 2001 commission,
Robert Pozen, to make this shift from wage to price indexing on a
progressive basis, maintaining wage indexing for the lowest-paid
workers.

Even Bush doesn't claim that the Pozen-Bush
privatization and benefit cut proposal will maintain benefits at their
current promised levels. Most of the controversty surrounding this
proposal involves the steep cut in benefits and du Pont is certainly
aware of this. Holding on to an idea too long is understandable.
Writing a misleading commentary trying to sell it is not.

Here are some of the best job opportunities as identified by the The Christian Science Monitor. Do they have it right? Or would you recommend other choices?

Now hiring: the hot jobs of the moment, by Ron Scherer, The Christian Science Monitor:
… Accounting, electrical engineering, oil and gas specialists: These
are just some of this year's hot jobs. Although experts are quick to
agree that the job market is not quite up to the late 1990s … there are
nevertheless numerous professions that are hiring as fast as the
resumés come in. Many positions require math or science skills … "The
hot jobs are in the forefront of technology and medicine, or they are
in the sweet spot of where the economy is growing like energy,
healthcare services, financial controls, and international," says John
Challenger of the Chicago outplacement firm Challenger, Gray &
Christmas. "Of the hot jobs, the most sustainable will be those where
you can't be outsourced."

The Bureau of Labor Statistics (BLS),
in its employment projections, forecasts the top five industries with
the fastest wage and salary employment growth between 2002 and 2012
are: software publishing; management, scientific. and technical
consulting services; care for the elderly; computer systems design; and
employment services. … the job market is still pretty strong for some
job categories. Here are some of the strongest areas:

•
Anything to do with energy, such as petroleum engineering or work on
oil rigs. "It's difficult finding skilled labor, professional
geologists, engineers," says Mark Baxter, director of the Maguire
Energy Institute at Southern Methodist University in Dallas…•
Accounting, which continues to grow. With the requirement that
companies comply with the Sarbanes-Oxley legislation, which compels
CEOs to certify their company's financial results, demand for
accounting services has soared…• Building trades, especially as America's love affair with real estate continues...• Computer security...• Healthcare...

Monday, May 23, 2005

David Wessel reported in the Wall Street Journal
that the Fed is becoming concerned about a potential housing bubble.
Those concerns were reiterated by Greenspan in the Q&A after
Friday’s energy speech (see Calculated Riskhere and here
for some enlightening quotes). I don’t blame Fed officials for raising
the alarm. I’m concerned, too. But the important question is what are
they prepared to do about it? I continue to believe that the Fed is not
likely to change the path of monetary policy to pop a housing bubble.

Bubbles
pose significant challenges for policymakers. They are economic
distortions that lead to inefficient resource allocation, and tend to
have nasty unexpected consequences when they pop. But to what extent,
if any, should they be a focus of central bank policy? I think
conventional wisdom at the Fed is that you should keep your eye on the
ball, and the ball is price stability. To deviate from this objective
pulls you into the uncertain world of bubble analysis. It is possible
that you may not be able to conclusively identify whether a bubble
exists until it is far too late to do anything about it. Moreover, the
Fed is not charged with maintaining stability within any one sector of
the economy, just as they cannot set monetary policy with a focus on
California. The Fed will instead focus on cleaning up after the bubble
pops (some will argue that this entails creating a new bubble somewhere
else in the economy).

Assuming that a more aggressive monetary
policy is off the table for the time being, what else could the Fed do
to address the housing bubble? Often, those of us following the Fed
forget that it is also charged, along with a number of other agencies,
with regulatory responsibilities over the financial industry. According
to Wessel:

The Fed and other bank regulators, however,
this week warned banks to take more care with home-equity loans, noting
that such loans are "subject to increased risk if interest rates rise
and home values decline."

And, from the Wall Street Journal, on the same day of Wessel’s piece:

New Mortgage Guidelines Planned:
Federal banking regulators, concerned about growing risks in the
mortgage market, are planning to issue new guidelines for mortgage
lenders.The new guidelines, which could be completed as soon as
early next year, come at a time of growing concern that the
proliferation of new mortgage products could mean higher risks to
borrowers and lenders. Regulators are turning their attention to
mortgages after issuing their first-ever guidelines for credit-risk
management for home-equity lending this week, warning financial
institutions to re-examine their loan criteria.

Note the
key phrase in this piece, "early next year." The regulatory process can
move at a glacial pace, so it is apparently premature to conclude that
banking regulators are about to put the kibosh on the housing market.
Moreover, regulators appear to be well behind the curve. See the
following piece, from the same day’s WSJ!

The Letter of Credit Returns. Buy beachfront property! Almost no money down!More
investors prowling some of the hottest real-estate in the country have
discovered an old-fashioned financing tool -- the letter of credit --
and are using it in a way that may be adding fuel to an already
overheated housing market.

…Some say letters of credit make it
too easy for speculators. Economists estimate about 20% of residential
property sales involve investors, not families or individuals who plan
to live in the home. Such purchasing could be artificially lifting
prices and demand and could destabilize a market should speculators
start dumping homes, these economists fear.

Looks
like the financial industry is working overtime to keep a fire under
the housing market. Does anyone out there believe that the regulators
can match their pace? And, lest we forget, interest rates have returned
to their "conundrum" levels (see William J. Polley).
With the financial industry pushing real estate, and low interest rates
ensuring cheap financing, it is tough to see that regulators have much
of a chance to get a handle on this bubble without cutting it off at
the knees.

So, given the lack of attractive policy options, or
the ineffectiveness of these options, why the very public shift in
concern at the Fed? I propose a very simple answer: The Fed is trying
to protect its reputation. In the past, Greenspan has clearly
downplayed the existence and impact of a housing bubble, even going so
far as praising ARMs. It is getting harder to make those arguments, and
consequently I suspect that Greenspan does not want to be blamed for
being the cheerleader behind another bubble (see Roach’s withering
criticism of Fed policy here). Unfortunately, it is probably too late for that – most of us in the blogosphere have long memories.

Simply
put, the Fed’s recent housing market concern is interesting and
important, but not by itself likely to trigger more aggressive monetary
policy. Instead, it appears to be more of a CYA maneuver – use the
regulatory process to strengthen (hopefully) the financial industry,
tell homebuyers they are taking a risk, and hope for the best.

Joseph Stiglitz, a professor at Columbia University and Nobel Prize
winner in economics in 2001 is not happy with the Bush administration:

No Old-Age Security in the Private Sector Either, By Joseph E. Stiglitz, LA Times:
President Bush's plan to reform Social Security requires that we trust
the private sector, which isn't all that easy to do given its inability
to honor its obligations in pensions or to provide adequate health
plans. The recent court decision allowing United Airlines to turn over
its pension system to the federal Pension Benefit Guaranty Corp. is
likely to raise anxieties still further among Americans already worried
about their old-age security. There is a certain irony to what's going
on: As the president tries to turn over responsibility for retirement
to the private sector, the private sector is simultaneously turning to
the government for help. … This apparently is part of the new form of
Bush capitalism, involving the nationalization of private liabilities.
The bonds of GM and Ford, once bastions of American capitalism, have
been downgraded to junk status … Is it only a matter of time before
they too turn to the government?

… The problems in the private
sector are, in many cases, a combination of bad accounting, greed and
lax government regulation that allowed corporations not only to put
insufficient pension funds aside in the first place but to raid
corporate pension funds they claimed were over-funded. The parallel to
what has occurred on the public side is uncanny. A combination of bad
accounting and political greed allowed the administration to claim that
huge surpluses justified a huge tax cut. The accounting was a mirage;
the surpluses soon disappeared, and fiscal solvency of the United
States was undermined.

If but a fraction of the money spent on
the tax cuts had been devoted to Social Security, the fiscal solvency
of the program would have been ensured for 75 years, even using
conservative projections. America is the richest country in the world.
We should have the ingenuity and means to design retirement programs
that insures Americans against stock market volatility and inflation.
Social Security is the only program that does this for most Americans.
United's experience shows that private pension programs cannot be
counted on. Private accounts would be subject to the vagaries of the
market. And no private program would insulate against inflation. We
should be focusing our attention on making our private system work
better. Certainly we should do that before we begin Bush's risky path
of beginning to dismantle our public one.

Sunday, May 22, 2005

News that House Ways and Means Chairman Bill Thomas will support
opt-out 401(k) accounts as a part of Social Security reform legislation:

Automatic Signup In 401(k)s Backed - Provision Eyed for Social Security Bill, By Jonathan Weisman, Washington Post:
House Ways and Means Chairman Bill Thomas (R-Calif.) will include a
provision in his Social Security legislation to help employers make
enrollment in 401(k) plans automatic unless workers choose to opt out,
according to congressional staff and knowledgeable lobbyists. The
provision could have substantial impact on the nation's savings rate …
Recent academic research has shown that employee participation rates
soar among companies with automatic enrollment in retirement plans. …
lobbyists who have met with Thomas say he has given his word on the
matter.

… According to two lobbyists familiar with the
discussions, Thomas has suggested to life insurance interests that he
would back incentives for employers to convert 401(k) balances to
private annuities that would pay out slowly over a worker's retirement.
In exchange, the life insurance industry would not work against a
dramatic expansion of Individual Retirement Accounts, 401(k)s and tax
incentives designed to expand personal retirement savings. … Economists
of all political stripes like it because it appears to work. …
Mandating automatic enrollment would easily create $20 billion in new
retirement savings a year, said Peter R. Orszag, director of the
Retirement Security Project … If Congress pushed employers to slowly
increase contribution rates over time, savings would increase well in
excess of $50 billion a year. …

I’ve been wondering whether to support such a proposal. The first question I had, which I asked here,
was what market failure justifies intervening to increase saving? If
the loanable funds market works, wouldn’t the saving rate, whatever it
is, be optimal? Through comments and an email, I am now convinced that
taxes drive a wedge between private and social investment returns, that
myopia might play a role, and that moral hazard may also be a problem
resulting in saving below the golden rule level. Thus, I am now
comfortable with government intervention to create incentives to
increase private saving.

That brings me to opt-out. I believe it
increases saving relative to opt-in, but why is this so? Do some people
perceive the transactions costs of changing status to be greater than
the benefits irrespective of whether they are asked to opt-in or
opt-out? In general, I hate opt-out programs. I don’t want to spend my
time filling out forms and checking boxes telling people all the things
I don’t want to buy. If I’m convinced there is market failure in the
market for bicycles resulting in too few being purchased, is the proper
solution to drop bicycles in people’s yards unless they remember to
send in the proper paperwork? I remember being in music clubs like that
when I was younger… Maybe a better answer is to work a little harder on
the incentives and ease of opting-in.

Last, I worry we have
forgotten the Lucas critique yet again. Change the rules and change the
behavior. I can imagine that if you impose opt-out now when it is
uncommon participation might be high. But as it becomes more common and
institutionalized people will more easily opt-out. In addition, it also
seems participation rates will fall in the long-run as people hit
financial stress points. If you can opt-out at will, then the first
time a family faces financial distress, they will likely opt-out.
Unless they are somehow brought back into the program later,
participation rates will fall as time passes and revenues may not meet
projected values.

Saturday, May 21, 2005

The National Review Online is unhappy with the progress of the Administration’s domestic agenda. Who do you think the National Review
blames? While this Kudlow column takes the obligatory jab at Democrats
as obstructionists and tries to tie the failure of Social Security and
other domestic reform proposals to the filibustering of judges, it is
evident that even the NRO is beginning to realize there is a clown show going on in Washington. And they aren’t laughing:

The Dreariest Political Spring, The hoped-for domestic-reform agenda has gone nowhere, Larry Kudlow, NRO:
Conservatives were near ecstatic last November when President Bush won
handily and the Republicans strengthened their hold in Congress. Hopes
were high that little could stop the implementation of a true
conservative agenda … But the hoped-for domestic-reform agenda has …
degenerated into a hopeless morass of name-calling, scandal-mongering,
political-bludgeoning, and relationship-breaking over the seemingly
simple issue of giving the president’s judicial nominees an up-or-down
vote. …

According to a recent Wall Street Journal/NBC News poll,
… Democrats receive a 47 percent approval rating while Republicans get
only 40 percent. These are the worst polling data for the GOP since the
eve of the Gingrich revolution of 1994. It is not, however, a perfect
poll. .... The single biggest problem facing Americans today seems to
be rising gasoline prices, with jobs and the economy following suit.
Yet seldom does Bush even talk about energy. Another key issue of
discontent is immigration. The president seems to want more of it while
the public clearly wants less. … pollster Scott Rasmussen points out a
real landmine for the Bush reform proposals of Social Security … it’s
the age group of 50 to 64 years that is completely opposed to what
they’re hearing. ... This group is the most likely segment of the
voting population for the midterm elections — not a good sign for GOP
strategists.

… Is the White House and its congressional allies
selling policy reforms that voters simply are not buying? … will
tax-reform commissioners Connie Mack and John Breaux ever get their
proposals to see the light of day in the current obstructionist
congressional climate? … All senators have dirt on their hands these
days. The Senate, if you can believe it, just delivered a
budget-busting pork-laden $295 billion highway bill, featuring several
thousand special-interest earmarks and a phony tax-transfer from
general revenues to the trust fund. Where was the allegedly
conservative Republican-controlled Senate? This bill was voted through
89 to 11 … the capital city seems to be disconnecting from the country.
... This is surely the dreariest political spring I can remember.

The
reluctance to give the Administration and GOP leadership in Congress
their full share of the responsibility for the public’s resistance to
reform efforts is evident, and the argument that every problem they
encounter is due to minority obstructionism is transparently weak, but
the NRO is beginning to
acknowledge that the failure of the Administration and Congress is
causing the dreariness surrounding the domestic-reform agenda they are
feeling this spring.

Friday, May 20, 2005

Here are some remarks on the nuts and bolts of how the Fed forecasts
inflation by Governor Donald L. Kohn. Points to note are (1) The Fed
uses a variety of models to forecast inflation including models with
naïve adaptive expectations to models with rational expectations and
wage and price frictions. The forecasts from these models are examined
in their totality and then “judgmentally adjusted” to arrive at a
forecast for inflation. Surveys of economists and the public are also
used to gain information about inflationary expectations. (2) The
evidence suggests the forecasts used by the FOMC have been biased
upward by .2% and have a variance that results in a .5% positive or
negative error about one third of the time. (3) The reason for the bias
may be due to an undetected fall in the natural rate of unemployment
which in turn caused an upward bias in the inflation forecasts. (4) The
remarks highlight the difficulty in estimating the natural rate of
unemployment contemporaneously and how that difficulty has led to
policy errors in the past. (5) A conclusion is that monetary policy
could be improved through two advances, better means of estimating
inflationary expectations and better means of estimating the natural
rate of unemployment. Given the policy errors made in the past due to
misperceptions concerning the natural rate of unemployment, I see it
this as an area of particular concern. That concern is heightened by
the large demographic changes likely to affect labor markets and the
economy in the years ahead. Here’s a link to the remarks with graphs
showing inflation forecast errors by the Fed from 1984-2000:

Here's something I've been wondering about
and I hope someone can help me. I hear repeatedly that the national
saving rate it too low. I am not arguing against that idea, one that
has been around since the mid 1990's, but why is this?

The
right is a strong proponent of using Social Security reform to increase
the saving rate. What market failure justifies such intervention into
the private sector? Why doesn't this market produce the proper amount
of saving? What market failure are those on the right, and others (many
on the left embrace this as well), trying to correct in their call to
increase saving through Social Security reform such as add-on accounts?

Is
it due to a distortion arising from the federal budget deficit, low
interest rates from Fed policy, or some other government policy? If so,
why not fix the distortion rather than try and further manipulate the
market to increase saving?

Before intervening, shouldn't we at
least identify the market failure? And if there is no market failure,
if markets always work as many believe, should we call for intervention?

Here is a graph of the deviation of the unemployment rate from its
natural rate, i.e. (UN-UN*), where UN* is the CBO’s estimate of the
natural rate of unemployment (the NAIRU, or non-accelerating inflation
rate of unemployment):

Remember
that negative numbers represent low unemployment and positive numbers
high unemployment. Notice how steadily the gap has been declining over
the time period since the end of 2003. At the end of the first quarter
of 2005 the natural rate of unemployment was 5.2% and the unemployment
rate 5.3% for a gap of .1%.

If you are the Fed and your job is
to assess the overall health of the labor market and you see this
diagram, what do you conclude? There are two views of the economy right
now, one that says the underlying economy is strong though there are
some noisy signals. This diagram would support that view.

But
suppose you disagree. Why would you argue this mis-measures the true
state of the labor market? There are two possibilities. The first is
that the natural rate is mis-measured. The CBO has not changed its
natural rate estimate of 5.2% since March of 1996. Prior to that it was
changed frequently. Has the natural rate changed? One reason it would
vary is changes in the age distribution of the population, but
significant changes in the age distribution do not appear until after
2010 as shown here so that is an unlikely explanation.

The
other possibility is that phenomena such as discouraged workers and
underemployed workers (people working part-time wishing they could work
full-time or working in an area different from their primary skill)
cause the measured unemployment rate to be lower than its true value
making the labor market appear stronger than it really is. If I wanted
to argue that the data do not represent the true state of the labor
market, I would focus here rather than the natural rate (or make the
point that the average misses the high level of unemployment among some
demographic groups).

But from a policy perspective this misses
the point. The Fed understands that the “thermometer” it uses to take
the temperature of the labor market may not give the true temperature.
It may read 85 degrees when it’s really 91. But it still tells the Fed
whether the labor market is getting hotter or colder which is what it
needs to know to determine the appropriate course for monetary policy.
It doesn’t matter if the thermometer is off by a few degrees, you can
still tell whether the temperature is rising or falling. As the Fed
looks at the data in the diagram, it sees a labor market that is
getting hotter irrespective of whether the actual measure should be
higher or lower.

There is very little good news in this survey report released today by The Pew Research Center for the People and the Press:

Economy, Iraq Weighing Down Bush Popularity - Country Losing Ground on Most National Problems:
Americans are critical of President Bush's job performance in many
policy areas, but negative opinions of his handling of the economy and
Iraq are doing the most damage to his overall approval rating … There
has been greater stability in Bush's marks on energy policy and Social
Security, but he gets positive ratings of only about 30% on both issues
(energy policy 31%, Social Security 29%). … Bush gets positive marks
from a majority of the public on just one issue ­ his handling of
terrorist threats. …

An
analysis of opinions on Bush's job performance shows that views of his
handling of the economy are now the biggest factor influencing his
overall rating, with Iraq nearly as important. … Negative opinions of
Bush's handling of Social Security outnumber positive ones by about a
two-to-one margin (59%-29%), but this issue does not heavily influence
Bush's overall job rating. However, Bush's association with a plan to
limit the growth of Social Security benefits appears to undermine
support for the concept. Most Americans say they would support limiting
the growth of benefits for wealthy and middle-income retirees, while
keeping the current system intact for lower-income people. But support
is significantly lower when the proposal is explicitly associated with
Bush. … While partisanship is a large factor, Bush also faces problems
on Social Security policy among political independents. Support among
independents … drops … when the proposal is attributed to the president.

Meanwhile,
public support for adding private accounts to Social Security, which
declined over the winter, has largely stabilized over the past three
months. Since February, there has consistently been a slim plurality
(currently 47%) in favor of the idea of allowing younger workers to
invest a portion of their Social Security taxes in private retirement
accounts, though nearly as many (40%) are opposed. Bush's endorsement
of this proposal is not mentioned in this survey question.

On
many key issues, from the budget deficit and Social Security to
education and illegal drugs, more Americans think the country is losing
ground than say it is making progress or holding its own. … Perceptions
that the nation is losing ground in health care have grown sharply over
the past decade or so. ... Opinions on the availability of good-paying
jobs, which improved considerably from 1997-2001, have declined in
recent years. … Not surprisingly, perceptions of the budget deficit
have worsened considerably … Democrats are decidedly more negative than
Republicans in their perceptions of how the country is doing on most of
these issues, with the biggest gaps over the availability of
good-paying jobs and environmental pollution. … On immigration, the
partisan pattern is reversed; more Republicans than Democrats believe
the country is losing ground on immigration …

Thursday, May 19, 2005

In his role as advocate for whatever the administration proposes,
Luskin shows that he is either willing to intentionally mislead, or he
does not understand basic concepts. First, he makes incorrect
statements about liberal bias in the media that a simple Google search
would have shown to be false. Second, he makes misleading claims about
increasess in future benefits. Finally, he makes an argument that
personal accounts as proposed by the administration protect future
benefits. This argument is incorrect as shown below.

On
Monday, Florida congressman Robert Wexler broke ranks with fellow
Democrats by offering a plan to reform Social Security. Amazing! After
months of party-line stonewalling, Wexler made a gesture of
bipartisanship. And yet there hasn’t been one solitary word about it in
the "paper of record," the New York Times.

Click the link above and see for yourself.

Next, let’s look at his claim that:

...
for the middle 20 percent of average lifetime wage earners — surely
that defines the “middle class” — progressive price indexing would
increase benefits payable in 2050 from $1,208 (in 2005 dollars) to
$1,380. And that doesn’t even include the additional increase in
benefits that would accrue from investing in personal accounts. And the
benefit improvement is even greater for workers below the middle class.

Here is more perspective on these numbers. According to calculations by Jason Furman of the Center on Budget and Policy Priorities available here,
a worker born in 1985 (who would be 65 in 2050) with a $50,000 income
would, under the existing commitment, receive a monthly payment from
Social Security of $2,355 per month ($28,260 annually). Under
Bush-Pozen, it falls $1,684 per month ($20,347 annually, a cut of
$7,913 or 28% relative to the current commitment).

Here’s
Luskin’s argument. Using my figures (I couldn’t verify his, but like
his, these are inflation adjusted), a retiree today with an income of
$50,000 would receive $1,654 per month and, under Bush-Pozen that
increases this increases to $1,696 for somone retiring in 2050, an
increase of $42 per month over today's payment (not quite as attractive
as the case Luskin chose to present). However, this is not an increase
relative to the current commitment to pay benefits, it represents a cut
of $7,913. Luskin wants us to believe we are better off because we
receive $43 more per month conveniently forgetting about the $7,913 cut
(which is $659 per month).

Finally, let’s look at one more claim that is used to argue against tax increases and for private accounts:

First,
Social Security is already running a surplus — it takes in more in
taxes each year than it will pay out in benefits (it will do so until
2017). Raising taxes today will just make that surplus larger. That’s a
problem because that surplus isn’t being saved for the sake of the
system’s future needs. The so-called Social Security Trust Fund uses
the surplus to buy special-issue Treasury bonds — which is to say, it
hands the surpluses over to the federal government to spend.

This
is the standard lockbox argument for private accounts. Having had the
solvency foundation crumble, this is their last resort, that the
lockbox will prevent the government from spending your money. But it
doesn’t, and closer inspection undermines this argument as well. Let’s
take a numerical example. Suppose you currently pay $100 in taxes for
promised benefits in the future of $100 (ignoring interest simplifies
the exposition but does not change the basic result), but the
government spends $20 so it only has the ability to pay $80 in the
future (i.e. the government spends $20 more than it takes in from
general fund revenues). Luskin is saying that if you raise taxes to
$120 to make up the shortfall, the government will simply spend the
extra $20 leaving the $20 shortfall in place.

But the government
can still do this even if part of the contribution is placed in a
private account. Suppose we take the $20 the government is spending and
put it into a private account to "lock it up" (this is like diverting
4% out of 12% to private accounts under the proposal). Thus, you now
give $80 to the government and put $20 into a private account. But the
government is still spending as before so now the shortfall increases
to $40 since revenues have fallen by $20. A solution is simple for the
government is to reduce promised benefits from $100 to $80 in the
future so that the shortfall is back to $20 again (or cut benefits to
$60 to achieve buget balance). There is nothing about private accounts
that prevents the government from reducing its share of the promised
benefits as a means of solving budget deficit problems arising from an
inability to reign in general fund spending.

As this shows,
private accounts as proposed by the Administration do not prevent the
government from spending your money and are no different than a tax
increase in that regard. The argument that private accounts protect
your retirement benefits is not correct because the government can
always reduce its share of benefits to fund deficit spending in other
parts of government.

This is a follow-up to Tim Duy’s most recent Fed Watch.
A recurring theme in the interpretation of monthly or quarterly data,
and something noted in Tim’s comments, is to be careful about placing
too much weight on the data for a particular month or quarter as they
are released. First, the data are often revised and the revisions can
have a substantial effect on the interpretation. However, even after
the data are revised information concerning trend movements in many
series measuring aggregate activity, prices, interest rates, and
monetary aggregates is difficult to extract due to their high
variability. Because of this, placing too much weight on the data for
any one month or quarter can give a false impression about the
underlying trend. As an example of this, here’s a graph of the monthly
growth rate in industrial production (IP) over the last ten years.
Superimposed upon the actual series is the smoothed value of IP (the
average value over five months centered on the actual value).

Notice
how noisy the monthly data are relative to the underlying value of the
trend. This shows how difficult it is to extract information about the
trend from any particular monthly release of the series (and these data
have been revised, the variance is even higher with unrevised data).

Why is the trend important? Here is a graph of the smoothed value of IP and the target value of the federal funds (FF) rate:

The
graph shows several important features of the relationship between the
target FF-rate and the growth rate of IP (deviations of IP from a
measure of its natural rate are highly correlated with deviations of
unemployment from the natural rate of unemployment as estimated by the
CBO so the use of IP as the measure of aggregate economic activity is
not critical to the conclusions). First, once the smoothed value is
extracted from IP growth it does appear to be correlated with the
FF-rate. More sophisticated econometric work confirms this association.

Second,
and importantly, in recent years policy has been persistent in the
sense of only changing after output growth has clearly deviated from
its recent history. Consider the period just before the May 2000 label
in the graph. In late 1999 the Fed began raising the FF-rate (the black
line measured on the right-hand axis) persistently. Even after the
growth in industrial production (the blue line measured on the
left-hand axis) began falling, the Fed continued raising the FF-rate
for a time period. Then, around May 2000 the FF-rate levels out as the
Fed pauses to assess the situation. Policy does not change until after
the IP growth rate falls for several months and then becomes negative.
At this point the Fed begins reducing the FF-rate rapidly until it
bottoms out just after May 2003. Thus, there is a lag between the
decline in IP growth and the change in policy as the Fed patiently
assesses the data over several time periods to make sure there is an
actual change in the underlying trend and not just a temporary blip in
the data. A similar delay in changing the course of the FF-rate is in
evidence when the FF-rate begins increasing around May 04 in the
diagram. The Fed does not change its policy immediately, and only
begins increasing the FF-rate after it observes several consecutive
months of positive growth. This shows, as Tim noted, that the Fed does
not change course easily and pays little attention any particular blip
in the data. The Fed operates deliberately, and changes policy only
after there is clear evidence that there has been a change in the
underlying trend rate of output growth or, more generally, inflation.

Wednesday, May 18, 2005

Today’s CPI report
does little to change the course of Fed policy. Indeed, it will help
cement the “measured” pace of tightening for the near future. On the
back of another strong gain in transportation costs (read: gasoline)
headline CPI gained 0.5% in April. But in a surprising development,
core prices remain unchanged. I will leave it to others to parse out
the details of the reports; there are, as always “special”
circumstances hidden within the individual components. I have never
been very confident Fed policymakers are much concerned with the
underlying details, unless, of course, one detail begins to dominate
the overall data. The Fed will concentrate their attention on the core
numbers, and conclude...drum role, please….that one month does not make
a pattern.

To be sure, there will be some relief on Constitution
Ave. that the report did not surprise on the upside and drive
expectations for a more than measured response. Still, core-CPI is
growing at a 2.6% annual rate for the last three months, clearly above
the Fed’s comfort zone. This underlying trend will remain the Fed’s
focus until it reverses itself (unlikely) or growth slows significantly.

Why
do I keep harping on the necessity for a significant slowing in growth
before the Fed changes course? Just look at yesterday’s comments
by Fed Governor Donald Kohn, speaking to the Australian Business
Economists: “…if growth is sustained and inflation remains contained,
we are likely to raise rates further at a measured pace.” And “The
federal funds rate appears still to be below the level that we would
expect to be consistent with the maintenance of stable inflation and
full employment over the medium run.” And, if that wasn’t clear enough,
“[W]e have not yet finished this task.” These are remarkably candid
remarks, and imply a high degree of confidence in the continuance of
existing policy. The recent bearish feelings on Wall Street are clearly
not receiving much validation in the inner circles of the Fed.

In other Fed news, it was announced this morning that Governor Edward Gramlich has tendered his resignation,
three years before his term was scheduled to expire (14 years is a long
time, and Gramlich took a spot with 11 years remaining on the clock). I
think this event will have little near term impact on policy. Indeed,
perhaps the candor of Kohn’s remarks was preparation for the
announcement of Gramlich’s departure. Gramlich was a somewhat dovish
member of the FOMC, and some could interpret his departure as setting
the stage for a more aggressive policy. Kohn’s comments should help
ease any such concerns. I will not comment on possible replacements for
Gramlich; your guesses are as good as mine.

Regarding replacements, however, the Washington Post is reporting this morning that the Administration is considering delaying Greenspan’s departure.
This is indeed important for policy, and confirms what I think many of
us has felt: That none of the names commonly mention for the Fed’s top
spot, Feldstein, Hubbard, and Bernanke, fill our hearts with warm
fuzzies. Indeed, the fact that this story was floated should make
Bernanke think twice before moving to the CEA. Apparently, there is no
guarantee of a Fed chairmanship down the line.

Is the
Administration somehow rewarding Greenspan for supporting tax cuts? I
doubt it. Instead, the possible delay more likely reflects the
challenges of finding a suitable replacement. Academic? Industrialist?
Financier? Or academic turned industrialist? Moreover, is there
pressure in the Administration to appoint simply on the basis on
politics, rather than on the best person for the job? This is my
greatest fear. The economy can survive a John Snow as Secretary of
Treasury. The same is not true for the Fed Chair.

Would former
Treasury Secretary Robert Rubin be a good replacement? Probably – but
not realistic. This Administration will not put the good of economy
ahead of politics. Rubin is a Democrat – enough said.

More
generally, what does the difficulty of finding names say about the
importance of Greenspan? I don’t want to believe that only he can do
this job. If the Administration delays his retirement, it suggests that
this is true, casting a pall over Greenspan’s eventual successor and
diminishing their credibility. Is this how we want to start off the
tenure of fresh blood in the Chairman’s seat? I don’t think so. Maybe
the blogging community should turn a fresh eye to the question of
possible names to replace Greenspan….

[Update: Calculated Risk comments
on the administration's claim of needing more time to broaden the
search: "'More time to broaden the search'? The White House wasn't
aware that Greenspan was retiring in January?" Brad Delong notes Calulated Risk's post and further notes the misrepresentation of Volcker's background in the article. William Polley says: "Appoint a successor sooner rather than later and don't play games with this position." The Prudent Investor weighs in with "Any delay could wreak havoc on the markets," and Global Trader Diary discusses at the possibility of deviating from a measured response.]

Expectations of a global slowdown are increasing according to this poll of investment fund mangers:

Investors: World economy looks dreary, Reuters:
Investors are becoming increasingly gloomy about prospects for the
world economy… Merrill Lynch … said its May poll of fund managers
showed the most negative growth expectations since 2001 and indicated
that a dramatic reassessment of investment strategy and economic views
was under way. ... changes in investor thinking in the two months since
its March survey had been "truly breathtaking." … said David Bowers,
Merrill's chief global strategist. "We are now starting to see people
position themselves for global growth disappointment." The poll of some
339 managers across the world … showed a clear majority of 56 percent
now expecting global growth to weaken slightly or a lot over the next
12 months. … Meanwhile, although most investors still expect inflation
to be higher over the next year, there were also signs that these
expectations are easing.

This article claims that raising the retirement age is the most obvious
solution to solvency problems for Social Security. While I don’t agree
with the doomsayers on the solvency issue, it is still worthwhile to
look at the costs and benefits of such a proposal. First, here’s the
article:

Why not raise retirement age? - Expert says it would fix Social Security, but it’s political trouble, David Gregory, NBC News:
The idea of raising the retirement age has somehow been lost in the
debate over changing Social Security for today’s workers. And yet it
seems to be the most obvious. … The Social Security retirement age is
now 65, but it's slowly going up. For those born in 1960 or later it
will be 67. But experts say you would have to raise it quickly to 72
over the next several years to make a real dent in the program's shaky
finances. … President Bush has said all ideas to shore up the program
are on the table. And yet few discuss raising the retirement age.
That's because in effect it's a benefit cut, just one of the reasons
it's political trouble. Among other reasons … raising the retirement
age would be especially hard for blue-collar workers … Critics also say
once you start raising the age, you can't stop if you want to keep up
with the shifting demographics. ...

Is raising the
retirement the most obvious solution? There are two benefits with
respect to solvency. Because people work longer, raising the retirement
age increases revenues coming into the Social Security system. Second,
because people retire later, the payout to retirees falls.

But what are the costs?

1.
An increase in life expectancy does not necessarily imply that people
are healthier at age 65 or 70 than before. Suppose, for example, that
medical advances are discovered that extend the end of life by several
years, but have no effect on health prior to the last few years of
life. In such a case there would be an increase in life expectancy, but
no increase in the health of workers at the age of retirement. If
people aren’t healthier, then increasing the retirement age imposes a
hardship over and above that faced by current retirees.

2.
It’s already difficult for elderly workers to find employment, and when
they do they are often underemployed relative to their skill levels.
Raising the retirement age will make this worse.

3. As noted in
the article, what about workers employed in physically demanding
occupations? Is it reasonable to ask them to work until, say, age 72?
If not, how equitable is it to have some workers work until 72, and
others allowed to retire at a younger age depending on their
occupation?

4. Will this distort
occupational choice decisions? Will workers, especially those who are
seeking work in the years close to retirement, choose strenuous jobs in
order to be allowed to retire earlier? How will we decide when a worker
is unable to work due to reasons associated with age?

5. The life
expectancy of some groups of workers is lower than for others. If
poorer workers die younger than richer workers on average, then raising
the retirement age will have a larger impact on low income workers and
thus, in essence, be regressive.

Do the benefits exceed the
costs? My choice would be to retire earlier rather than later even if
that requires progressively higher taxes or means tested benefits.

[Update: Robert Samuelson advocates raising the retirement age to 70 in his column today - he believes people should work as long a they are able to do so.]

The New York Times
reports the results of an experiment to see how well matching funds
work as a mechanism to increase saving. The results show that matching
funds cause an increase in the number of people who save and increases
the average amount saved by each individual. This implies that add-on
accounts with two features, government or employer matches and opt-out
rather than opt-in provisions are an attractive option to pursue in
reforming Social Security in a way that increases national saving.
There is direct evidence that matching funds increase saving, and
though the opt-out provision is not examined directly, the study does
show that ease of making the contributions is important:

H&R Blockbuster, NY Times:
… Half of all American households have little, if anything, saved
specifically for retirement … conventional wisdom holds that there's no
way to get people to save more. Happily, the conventional wisdom is
wrong. … lawmakers should pay close attention to the results of an
experiment that was conducted this year at 60 offices of H&R Block
in the St. Louis area. From March 5 to April 5, some 15,000 H&R
Block clients, most of them low- or middle-income, were offered free
help setting up I.R.A.'s. They were randomly assigned to three groups:
people in one group got a 20 percent match for I.R.A. contributions of
up to $1,000; another group got a 50 percent match on such
contributions. Still others - in the control group - were offered no
matching funds. H&R Block put up the money for the matching
deposits, eventually spending $500,000. The test was designed and
evaluated by researchers from the Retirement Security Project, whose
lead sponsor is the Pew Charitable Trusts.

The experiment
generated two broad findings: First, offering a match not only causes
I.R.A. participation to rise, but also increases the amounts people
contribute. A total of 1,500 taxpayers chose to contribute to I.R.A.'s;
participation rates were 3 percent in the control group, 10 percent in
the 20 percent match group, and 17 percent in the 50 percent match
group. The average contributions for the people in the match groups
(not counting the H&R Block matching funds) were at least 50
percent as high as in the control group, which got no match. Second,
the information provided by the H&R Block tax preparers and the
ease of contributing greatly influenced the participants' decisions to
save; most of the participants simply diverted portions of their tax
refunds into their I.R.A.'s. Full details of how the test isolated
these and other factors that bore directly on the savers' decisions are
available at www.retirementsecurityproject.org. Although it seems like
common sense that offering matching funds would increase I.R.A.
participation and contributions, that hypothesis had never been
rigorously tested before now. And Congress has never incorporated such
direct matches into the savings incentives it provides. Instead,
Congress's chief tax writer - Representative Bill Thomas of California
- and most of his fellow Republican lawmakers continue to emphasize new
tax-deductible savings plans and higher contribution limits for the
current tax-favored accounts. Such incentives have failed in the past
to motivate most taxpayers to save much, and they won't work now. A big
reason for that result is that tax deductions and lofty contribution
limits provide the most value to affluent, high-tax-bracket filers, not
to low- and middle-income taxpayers. … Lawmakers in Washington could
establish a generous and easily understandable I.R.A. match for a
fraction of what it would cost to extend the Bush tax cuts for the
wealthy. The evidence in favor of doing so is compelling. Then, when
the ideological din abates, a future Congress can enact the reforms
that are actually needed to strengthen Social Security after
midcentury: modest tax increases and tempered benefit cuts, phased in
over decades.

Tuesday, May 17, 2005

Cheney, Greenspan 'Friend,' Key Player in Fed Choice, Bloomberg:
Only one guest attended both Alan Greenspan's 50th birthday party and
his 75th: Vice President Dick Cheney. Cheney is likely to be a central
player in figuring out who will replace the Federal Reserve chairman
when Greenspan's non- renewable term as a governor expires in January
2006. It will be one of the most important decisions President George
W. Bush makes in office, and Cheney is alone in the administration in
having long-standing personal and professional relationships with both
Greenspan and the president. … Cheney, 64, and Greenspan, 79, spend
time together socially and have sat down to talk privately on the eve
of economy-rattling events, such as the Persian Gulf War in 1991, when
Cheney was secretary of defense under former President George H.W.
Bush, and the invasion of Iraq in 2003. Former Cheney advisers say the
vice president usually is involved in economic discussions of large
consequence, such as tax or energy policy. The two men met on 17
occasions from January 2001 through March 2004, according to a record
of the Fed chairman's appointments made public under a Freedom of
Information … "They're friends,'' said Mary Matalin, a former top aide
to Cheney who also has served as a political adviser to the Bush-
Cheney election campaign. Greenspan has even found time in his Fed
schedule to meet with Cheney's wife, Lynne, who is a senior fellow at
the American Enterprise Institute, a Washington research organization.
… Matalin and other Cheney aides add that there are boundaries in the
Cheney-Greenspan relationship when it comes to the Fed's independence
and picking a new chairman. "There is an official distance,'' Matalin
said.

Low taxes, free markets, and open borders can overcome incompetent economic policy according to an article at The Weekly Standard.
This article argues that the U.S. is poised for continued global
economic dominance in spite of the Bush administration’s economic
policy, not because of it. Particular scorn is directed at Treasury and
at the influence that Rove and associates have on economic policy. The
reasons for economic dominance in the future cited in the article are
(1) low taxes causing workers to work long hours, (2) excessive
regulation throughout Europe, (3) liberal immigration policy in the
U.S., and (4) China is limited by an unwillingness to fully implement
market-based incentives and an aging population limits its capacity for
growth. In addition, note the comments about Bush's series of
flip-flops on Social Security reform and the accusation that the
administration has retreated from its claim of a “crisis” when the
numbers did not support it. Given the source, this is strong criticism
of adminstration policy:

Spanning the Globe: Is America really positioned for continued global economic dominance? You bet., Irwin M. Stelzer, Daily Standard:
… [T]hose who want to worry about the American economy have enough to
keep them awake at night. But take a longer-run view of the nation's
economic prospects, and tossing and turning will give way to a George
W. Bush-style solid 10 hours of restful sleep. Not that the president
is exactly at the top of his form when it comes to economics. Even his
most ardent supporters moan at the incompetence of his team, especially
the crew at the Treasury. They deplore the extent to which Karl Rove's
political machine now determines and dominates economic policy-making.
Not all great political kingmakers make great economic policymakers.

Little
surprise, then, that Bush has so badly botched his efforts to "reform"
the Social Security system. First, he declared it to be in "crisis,"
only to retreat from that claim when the numbers proved it difficult to
sustain. Then he called for personal accounts, only to find that
earnings on such accounts might be too low to make them attractive.
Finally, he was forced to concede that his plan will involve a major
reduction in what middle-income and high-earners have been led to
believe they will receive from an unreformed system. The president
promised to spend his political capital; instead, he seems to have
squandered it. All interesting stuff, but … only the most jaundiced
observer can deny that … America's preeminence is assured for decades
to come. The continent's leading economies are bedeviled by
double-digit unemployment that is a result of rigid labor markets and
excessive regulation. Their leaders' solution? More rigidity, more
regulation… in America, worker productivity continues to outpace that
of Europe, in part because low taxes give American workers an incentive
to work longer hours. … By contrast, most (but not all) Americans seem
to agree with President Bush that immigrants make a positive
contribution to the American economy. Mexicans pour across the porous
border in pursuit of work and, in many cases, the American dream. …

Which
brings us to China, clearly a rising economic power. But there is an
emerging view that the Chinese will grow old before they grow rich,
such is the age distribution of the population. Equally important, the
Chinese regime is finding it increasingly difficult to … allow the wide
range of freedoms that an entrepreneurial class must have if it is to
drive national prosperity.

…[In the] American economy ...
inflation is under control, millions of jobs are being created every
year, profits are rising, the federal deficit is declining relative to
the size of the economy, and even the massive trade deficit may have
started to come down. There aren't many countries that can match that
performance.

America
today reminds me of our last Olympic basketball team - that
lackadaisical group that brought home the bronze medal. We think that
all we need to do is show up and everyone else will fold - because,
after all, we're just competing with ourselves.

Complacency would be a mistake and the attitude Friedman warns about is displayed in the Weekly Standard
article. Despite "incompetent" policy and "botched efforts," there is
nothing to worry about. Why not prepare for rigorous competition and be
surprised by an easy win instead of assuming an easy win and being
surprised by the strength and intensity of the competition? We have not
done enough to prepare for global competition in the future. Investment
in infrastructure, investment in education at all levels, increases in
job retraining, worker relocation, and other programs to mitigate the
costs of transition to the global economy, and government policy that
chooses long-run economic goals over short-run political considerations
are keys to success.

Central banks were net sellers of U.S. assets in March for the first time in several years:

Fears for dollar as central banks sell US assets, Christopher Swann in Washington and Richard Beales in New York, FT:
The world's central banks were net sellers of US assets in March for
the first time since September 2002, according to figures that may hint
that the recent rebound in the dollar will be temporary. … “For those
central banks that are not managing their currencies, there may well be
a feeling that the dollar is not a great bet,” said Adam Cole, currency
strategist at RBC Capital Markets. Economists says these sales may be a
sign that central bank officials fear the dollar downtrend will at some
point resume. … “It does seem that when private sector investors are
willing to buy dollars, the central banks are happy for any excuse to
offload part of the mountain of dollars they have accumulated,” said
David Bloom, currency strategist at HSBC. … Some analysts suggest that
hedge fund buying of US government bonds in recent months may be
associated with unwinding failed bets in which the funds were short on
Treasuries while owning riskier, higher-yielding debt. … Among the
central banks, reserve accumulation has been particularly aggressive in
Asia … Although the US trade deficit narrowed in March from $60.6bn to
$55bn, most economists believe this was due to a shortlived slowdown in
US demand and the timing of the Chinese new year. ...

Once again, the U.S. House has voted to
create a one dollar coin and the Senate is also expected to vote in
favor of the bill. Following the failure one dollar coins featuring
Susan B. Anthony and Sacagawea, this time the coins will turn to the
tried and true faces of U.S. presidents in the hope of enhancing the
chances for success:

Kill the dollar bill, Editorial, Chicago Tribune, May 16, 2005:
The U.S. House has voted to create a new gold-color $1 coin, and the
U.S. Senate is likely to follow suit. History suggests that this coin
already is doomed. People have avoided having to use the two previous
dollar coins, featuring Susan B. Anthony, the women's suffrage and
abolitionist leader, and Sacagawea, the Shoshone guide to Lewis and
Clark. … This time, the $1 coin will have the faces of U.S. presidents.
But let's be honest, most of the greats--Washington, Lincoln,
Jefferson--already grace the sides of coins. The likes of James
Garfield and John Tyler won't inspire people to rush out and stock up.

There's
only one way a dollar coin will be a success: Get rid of the $1 bill.
The U.S. Government Accountability Office has attributed the failures
of the Susan B. Anthony and the Sacagawea coins primarily to the
unwillingness of Congress to do away with the paper dollar. … Dump the
dollar? Forget it. Congress has opted every time to dump that idea
instead. … The sponsors of the new dollar coin hope it will match the
success of the quarter series featuring the 50 states. Those quarters,
introduced in the 1990s, have generated $5 billion in profits for the
government, according to U.S. Treasury estimates. It costs less than 5
cents to produce each 25-cent piece and the quarters have become
popular collectibles. …

Take a close look at Abe Lincoln on the $5.00 bill.
I don’t mind carrying Abe’s picture in my pocket and passing it along
to others. It wasn’t the pictures on the one dollar coins that drove
them out of circulation and I don’t see how it will different this time
just because the coins now feature Garfield or some other president.
But there is another reason to issue the coins. As noted, issuing
quarters that go out of circulation (e.g. collecting all 50 state's
commemorative quarters) has generated $5 billion in profits. Dollar
coins that go out of circulation and into cookie jars and coin
collections would be even more profitable.
Comments from old site

Monday, May 16, 2005

PGL from Angry Bear noted in the comment to the post on the Senator Schumer’s Social In-Security Calculator
that the cuts in benefits under the best representation we have of the
administration’s proposal are larger for younger workers. Since the
president has said
again and again that his proposal represents a “better deal for younger
workers,” I decided to use the calculator as a data generating
mechanism to check this by plugging in various ages and incomes and
recording the output. Here are two graphs of the resulting data showing
the relationship between age and benefit cuts under Pozen-Bush:

The
first is a graph of the value of benefit cuts by age stratified by
average lifetime income. The second graph presents the benefit
reductions as a percent of average lifetime income. The graphs show two
important features of the proposal. First, whatever the president means
by the phrase “a better deal for younger workers,” this isn’t it. As
shown in the first graph, no matter what income level is considered,
benefit cuts are larger the younger a worker is when the Pozen-Bush
reform proposal is put into place. Second, as a percentage of
pre-retirement income, the benefit cuts are initially progressive as
claimed in the name "progressive indexing," but then turn regressive
after approximately $50,000 in the graph. (For people with incomes over
$90,000 the cuts become smaller and smaller as a percentage of income
because the benefits and cuts are the same for anyone with an income of
$90,000 or above.)

One final note. This is not just the reduced
benefit from the government. The calculation of the reduction in
benefits includes both the amount the government promises to pay plus
the average amount workers would earn from personal accounts. The word
average is important because there will be winners and losers under the
proposal and the calculation of losses shown in the diagram does not
account for the increased risk workers will face with personal accounts.

This paper by David Boaz, Executive Vice
President of the Cato Institute, asks an important question, one that
societies have struggled with for hundreds of years. What is the proper
role of government in our lives? Unfortunately, in answering the
question he fails to make the important distinction between the role of
government in our social lives and the role of government in our
economic lives:

No Federalism on the Right, By David Boaz, May 15, 2005:
… Federalism has always been a key element of American conservatism. …
Lately… conservatives … have forgotten their longstanding commitment to
reduce federal power and intrusiveness and return many governmental
functions to the states. Instead, they have taken to using their
newfound power to impose their own ideas on the whole country. … Some
liberals are rediscovering the virtues of federalism. ... The prospect
of a constitutional amendment banning gay marriage has made many
liberals appreciate the virtues of having 50 states, each free to make
its own marriage law. … Maybe it would even be OK for Los Angeles and
Louisiana to have different environmental regulations. But most
liberals can't give up their addiction to centralization. Even as they
rail against federal intervention in the Schiavo case … they push for
stricter regulations on pesticides and painkillers ... Only one modern
political party has a history of taking federalism seriously, but
Republicans have decided to abandon this principle to pander to small
but vocal constituencies …

I’m not sure why he is upset with liberals for wanting stricter regulations on painkillers, but I’ll set that aside.

Here’s
what bothers me about the complaint that liberals are inconsitent for
wanting the government out of the bedroom but involved in
environmentaol regulation. There is a difference between social
conservatism and economic conservatism. I want the government to stay
out of my personal and social life. Period. But I do want the
government to use economic principles to design policies to overcome
market failures such as those brought about by pollution externalities.
I do want monopoly power broken up. I do want information disclosure
regulation in place when I buy a house. I want the government to help
if I my private property is stolen. The idea that capitalism will
produce competitive outcomes, or that trade will necessarily exist at
all without government intervention is wrong. Evidence of that abounds
when we look at the difficulty countries have had making the transition
from centrally a planned economies to capitalist economies. One of the
large lessons in that experience is the importance of government
institutions in setting the conditions for capitalism and competition
to flourish. It is a question of how much the government should
intervene, not whether the government should intervene at all.

The
point is that there is an economic basis for intervening in some
markets. Firms that produce pollution ought to pay the costs associated
with it instead of being allowed to pass the costs on to society as a
whole. There can be honest disagreement about whether there should be
private sector solutions such as tradable pollution permits or control
by government decree, but that is an argument about the form of the
government intervention, not about whether intervention should exist.

There
is no such economic foundation for many social issues and it confounds
the important question of the role of government in our social and
economic lives when the two are mixed together. I want the government
to intervene to overcome market failures inherent in capitalism. I
guess that makes me a liberal. But I want the government to stay the
out of my bedroom, out of my death, and out of the birth of my
children. I want the government out of my social and personal life to
the extent possible. These days, that makes me a liberal too.

The week ahead, by Paul J. Lim, U.S. News & World Report, 5/16/05:
For the second straight week, the health of the retail economy takes
center stage on Wall Street, with scores of bellwether retail companies
reporting their quarterly results. Among them: Home Depot, Lowe's,
Barnes & Noble, and Staples. Meanwhile, the Labor Department will
release the latest results of its consumer price index, which measures
inflation at the retail level.

Monday, May 16:

EMPIRE MANUFACTURING INDEX:
Wall Street learns about the health of the factory sector in the Empire
State when the Federal Reserve Bank of New York reveals its survey of
manufacturing activity.

PPI:
The Labor Department is scheduled to release the latest findings of its
Producer Price Index, a key gauge of inflation at the wholesale level.
In March, the PPI rose a higher-than-expected 0.7 percent. But
economists are forecasting a much more modest increase of 0.3 percent
in the April report.

HOUSING STARTS:
Housing starts are a key indicator of the health of the economy, as
they reflect the confidence that homebuilders have in the ongoing
strength of consumers. In March, housing starts plunged 17.6 percent,
the biggest monthly drop in 14 years. But many on Wall Street are
forecasting a turnaround in housing starts, which are expected to be up
around 7 percent in April.

CPI:
The Labor Department this morning reveals the latest findings of its
Consumer Price Index, a key gauge of inflation at the retail level. In
March, the CPI rose a higher-than-expected 0.6 percent. But economists
are predicting a much milder increase of 0.4 percent in the April
report.

INDEX OF LEADING INDICATORS:
The Conference Board releases the latest results of its closely
followed Index of Leading Economic Indicators. The index fell 0.4
percent in March. And it's expected to have fallen another 0.2 percent
in April.

FEDSPEAK:
Several Federal Reserve Board officials are scheduled to speak at
various events across the country today. Both Fed chairman Alan
Greenspan and Atlanta Fed president Jack Guynn are slated to speak at a
housing and economics conference sponsored by the Federal Reserve Bank
of Atlanta. Meanwhile, Fed governor Susan Schmidt Bies will address a
conference in Boston while Chicago Fed president Michael Moscow and Fed
governor Mark Olson will speak at a conference in the Windy City.

Saturday, May 14, 2005

This is from a speech from the president on May 13 posted on the White House web site.
First, the president says the government will not keep its promises to
younger workers. Then, he jokes that the problem is because "we take
your money and we spend it." If that’s the problem, how about showing
some leadership and doing something about it? Take ownership and
personal responsibility for the budget problems your administration
created (you could look for the missing veto pen). For example, rolling
back the tax cuts the administration put into place would produce 3-5 times the revenue shortfall
in the Social Security Trust Fund. Cutting taxes, creating a crisis,
and then joking about it is not the answer. Quoting the president:

I
want to spend some time today talking about … Social Security. … one
thing is for certain … Social Security is headed for serious financial
trouble. … if you're a younger American, our government has made
promises to you that it cannot keep.

Social Security really is on the path to bankruptcy -- … we take your money and we spend it. (Laughter.) …

… Social Security is a pay-as-you-go system. I alluded to it earlier -- you pay, we go ahead and spend. (Laughter.) …

Laughing all the way to the bank perhaps? The administration also says
it doesn’t necessarily endorse the Pozen plan (as noted in this statement from Brad DeLong). Yet the president says:

So
I proposed a Social Security system in the future where … all workers
will get Social Security checks bigger than the ones they receive
today, but that the benefits will rise at a rate we can better afford.
This idea was suggested by a fellow named Robert Pozen …

Finally, he is still proposing that workers invest in a losing investment (as shown here):

The other thing is there will be plenty of options. For example, you can invest all in T-bills, Treasury bonds. …

Summing
up, the administration does not intend to keep government promises to
younger workers; the Social Security problem is because "we spend it;"
it's something to joke about; the administration does not endorse the
Pozen plan officially but implies otherwise in speeches; and the
administration is suggesting workers invest in an account consisting of
all Treasury bonds or notes that offers a negative risk-free rate of
return.